PRIVATE DEMAND MUST RISE

Reform delays discouraging

Junichiro Koizumi was Japan’s first prime minister to receive a mandate to push structural reforms by convincing the public that there would be no economic growth without painful reforms. It remains to be seen, however, whether Koizumi will succeed in his reforms. More than a year after launching his administration, it is still unclear how Koizumi will spur economic recovery, as he depends, in running the government, on the ruling Liberal Democratic Party’s major factions, which often resist his reform efforts. This makes public support of his government fragile.

The current economic stagnation stems from insufficient private demand to drive the economy. Without public works spending, which accounts for about 8 percent of the gross domestic product, the economy would collapse. This is the basic cause of Japan’s fiscal crisis. Therefore, structural reforms should aim at creating private demand to make up for the necessary cuts in fiscal spending. This is the only way to achieve self-sustaining economic growth and fiscal health.

The “recovery-or-reform” debate concerns ways of ending deflation — traditional fiscal spending or structural reforms for creating private demand. The latter is the only alternative for Japan, which has used up all its monetary and fiscal policy options. This is the lesson that Japan should have learned after wasting a decade in implementing stopgap fiscal spending to delay reforms.

To create new private demand, Japan must first restore its competitiveness as a business location. The government paper “2002 Economic and Fiscal Management and Structural Reforms” says Japan has failed to adapt to economic globalization. That is why many companies have relocated their production plants overseas. It recognizes that the government is also exposed to international competition in trying to improve Japan’s environment for business activities. Strangely, this recognition does not constitute a core principle in Koizumi’s reform agenda.

In a Financial Times interview published May 13, Koizumi said he would give priorities in his reform plans this year to privatizing highway corporations and postal services as well as to disposing of banks’ bad loans. A major problem with Koizumi’s reform agenda is that it places higher priority on privatization than on tax reforms and deregulation, which are essential for encouraging business activity. The misplaced priorities have caused private demand to decrease, rather than increase, aggravating the recession. No wonder that disposal of bad loans is making little headway.

The debate over tax reform, which finally started last May after a yearlong delay, includes proposals that would hamper economic revitalization. To restore fiscal health, the income tax and the consumption tax must be raised sooner or later. Care must be taken, though, to minimize the effects of tax hikes on consumer spending, which has remained more or less stable and bolstered the sluggish economy.

The proposal to narrow the gap in income tax rates by raising the minimum rate and cutting the maximum rate — the latter as an incentive for high-income earners — is likely to reduce spending and deal a blow to the economy. This is because it would redistribute much of the disposable income from those with a high propensity to consume to those with lower propensity to do so.

Members of the government’s Fiscal and Economic Council do not seem to realize that the major economic problem in Japan, unlike in the United States, is too much saving and too little spending. Koizumi’s reform agenda will lose much needed public support if policymakers remain indifferent to incentives for the majority, while concentrating on a limited number of high-income earners. The tax rate for the highest income group in Japan is roughly equal to that in the U.S.

The proposed size-based local business tax — according to wages and capital — will apply to all companies. Increased labor and capital costs would give an additional impetus to Japanese companies to move production and employment overseas as well as dampen investments and entrepreneurships in Japan. It would victimize employment and capital, retarding economic revitalization and fiscal health. Germany and France have abolished similar taxes, which they realized choked business activities.

A natural alternative is to increase the consumption tax, which businesses and individuals must pay regardless of their incomes. The government should present the entire picture of Japan’s crisis to the voters and make every effort to persuade them to accept a higher tax.

Regarding deregulation, the government repeats such rhetoric as “strengthening Japan’s industrial competitiveness through deregulation of the transportation, distribution, energy and information-technology sectors.” Yet delays in reform are very discouraging.

For example, the government plans to “accelerate, as from fiscal 2002, efforts to open major ports 24 hours a day as soon as possible.” But because of high costs and complicated regulations, major distribution bases have already moved to neighboring countries.

The direction of Koizumi’s reforms remains fuzzy because his programs are filled with empty rhetoric and proposals impeding economic revitalization. This clouds the path to self-sustaining economic growth, making the voters anxious. They are also disappointed with the lack of decisive government measures to deal with a spate of political scandals. Public support ratings of 40 to 50 percent could drop and prove fatal for Koizumi administration.

Japan’s predicament is that, if the Koizumi administration fails, there will be no alternative government to push reforms. The voters do not want a government controlled by the LDP’s old-guard, but the opposition Democratic Party of Japan is unlikely to come up with credible reform plans.

Koizumi reforms present an opportunity that is too precious to lose. This chance for the Japanese people will be lost if time is wasted as a result of misplaced priorities and a fuzzy process to economic growth.

It is not enough for Koizumi to merely repeat his determination; he must revise his plans to secure public support. Koizumi’s economic advisers are also to blame for the defects in his reform plans. Koizumi should not hesitate to reshuffle his team of economic advisers.